Limit, Stop-Loss, or Trailing: A Few of Your Exit Order Options

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Ticker Tape Editors

November 10, 2016

You probably know you should have a trade plan in place before entering an options trade. But what does that really mean? Here are a few ideas for creating your own trade plan, along with some of the order types you can use to implement it.

Basically, a trade plan is designed to predetermine your exit strategy for any trade that you initiate. That’s pre-determine, as in, before you actually make the trade. If you make your trade plan in advance, your overall approach won’t be influenced by the market occurrences that can, and probably will, affect your thinking after the trade is placed.

Plan Your Exit Strategy

There’s no one-size-fits-all trade plan, but at the very least, plan your exit points based on a certain profit target or specific loss tolerance.

For example, suppose you bought the XYZ January 80 call for $3. You may want to set exits based on a percentage gain or loss of the trade. Using percentages instead of dollar amounts allows you to treat your trades equally. For example, some traders will exit option trades at a 50% loss or a 100% gain. So that’s their basic plan, at least on paper.

Exiting with a profit of 100% would mean selling the January 80 call for $6. If the price were to happen to go over $6, you’d get your original $3 back, plus $3 more, for a 100% return (less commission costs). Exiting the trade with a 50% loss would mean selling the call if it drops to $1.50, which is half of the entry price.

Exit Order Up

Next, you can place the orders that would close out the trade according to your plan. The profit exit could use a basic “limit order” to sell the calls at $6. The loss exit could use a “stop-loss” order, which specifies a trigger price to become active, and then it closes your trade at the market price, meaning the best available price.

In this example, you would set a stop-loss order at $1.50. Once the call option drops to $1.50, the order activates and the option is sold at the market price. Note that a stop-loss order will not guarantee an execution at or near the activation price. No one knows exactly where a market order will fill. It could fill close to $1.50 or very far from that price. Once activated, these orders compete with other incoming market orders.

You could place these two orders together using an “OCO” order, which stands for “one cancels other.” Once either order gets filled, the remaining order is canceled automatically. The OCO aspect is what would allow two seemingly conflicting closing orders to be in effect at the same time.

This same logic could apply to a bearish trade on XYZ. Suppose you paid $4 for the December 60 puts. You could try to close the order at a 100% profit (minus commission costs) by placing a limit order at $8. Or try to close them with a 50% loss by selling them with a stop-loss of $2. Keep in mind that the stop-loss order doesn’t guarantee you’ll get the trigger price. And, again, an OCO order might be useful for entering both orders.

Trail to Manage Risk or Profits?

Another order type to consider is a “trailing” stop-loss. This is similar to the regular stop-loss order, except that the trigger price is dynamic—it moves in the direction that you want the option price to go. If a stock or option price moves in your favor, and the trail stop adjusts up for a long position and down for a short position, it gets closer to triggering if up and down price movements have been taking place.

Let’s say that with the January 80 calls, instead of using the stop-loss order to cut your losses, you use a trailing stop-loss order of $1.50. This means the trigger price will be $1.50 lower than the highest price the option attains. If the option moves up to $5, then the trigger price will become $3.50 ($5.00 - $1.50). Stop-loss orders can be used to try to lock in a profit rather than limit a 50% loss. If you hold a position that currently shows a profit, you may place a stop order at a point between the purchase price and the current price.

These order types work with several strategies—on the long side as well as the short side. As a short example, let’s say you sold a November 50 cash-secured put on XYZ for $2. On the profit side you could enter a limit order to buy the puts for $0.05. Although you wouldn’t receive 100% of your profit potential, closing the put eliminates the risk of remaining in the trade and may free up capital for other trades.

The exit trade on the loss side could be a stop-loss order to buy the puts if the price rises to $3, which would exit the trade with a loss that’s about 50%. Or you could use a $1 trailing stop-loss order. So if the puts dropped to $0.75, for instance, the trailing trigger price would be $1.75.

These are just a few of the different types of exits you can use, along with various order types for implementing your plan.

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A trailing stop or stop loss order will not guarantee an execution at or near the activation price. Once activated, they compete with other incoming market orders.

Market volatility, volume, and system availability may delay account access and trade executions.

Past performance of a security or strategy does not guarantee future results or success.

Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.

Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.

The information is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.

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